Salmon Evolution Q4 Report - my ruminations if you want them

I posted an off-the-cuff response to a first glance at Salmon Evolution’s Q4 report. I think my assessment was not unduly harsh, but I was wrong on at least one account so I thought I should do a deeper dive. Here it is.

First the good news

Salmon Evolution KPIs from Q4 2024

Their biological production results are very good. Going from left to right on the chart above:

1)        The tight weight distribution at harvest generally indicates that the fish are fully fed, and their feed system is giving the entire population an opportunity to feed. In underfed populations, bimodal populations are often observed – a population of dominant feeders can prevent more passive fish from accessing feed. No information provided on feed conversion ratios.

2)        2.6% mortality to 4.0 kg head-on-gutted weight is an excellent result – particularly for an early group in a production system. I think this result demonstrates the salmon in this system are well protected from pests, disease and environmental damage.

3)        A 96% superior grade share demonstrates the fish are in excellent condition – no damage and very few deformities. In the Norwegian market, grading standards are strict so the risk that standards are being lowered to boost this number is low.

Another positive to take from this report – and most of their previous reporting, is that they are transparent in reporting costs. Their reporting is clear and concise and provides excellent information on their biological performance. Most salmon farmers are more oblique about this information – it can be hard to really get a sense of how well or poorly things are going. This is particularly true in the salmon business where production problems that impact production volumes have a habit of pushing sales prices into the stratosphere. If you only focus on bottom-line returns, you can develop the wrong impression. If costs and biological performance are deteriorating and a producer is able to maintain the bottom line through price increases, it can mask an underlying problem that can put the long-term viability of the business in question.

My key criticisms of this report

Here are the key highlights from the first pages of the quarterly report.

Key Highlights - Salmon Evolution Q4 2024 Report

My primary concern is with the second bullet point. While EBITDA – (earnings before interest taxes depreciation and amortization) is a good metric for looking at the cash generation of your day-to-day business operations, it ignores the costs of ownership and interest paid for loans and other financed amounts. (caveat – I’m not an accountant but I’ve spent a lot of time annoying them). With a land-based facility like Salmon Evolution, the costs of construction are enormous – far higher than net pen operations for a similar volume and the depreciation amounts cannot be ignored.

The norm in the salmon industry is to report EBIT/kg. Here is a snip from the Mowi Industry Handbook 2024

Mowi Industry Handbook 2024

If an investor wants to compare results, EBIT/kg is the gold standard. You can see from above, depreciation is an important cost component.

Related to this, here are the EBIT/kg rankings for the Norwegian industry in Q2 2024:

Norway EBIT/kg rankings Q2 2024

Here is a quick comparison of Salmon Evolution’s Q4 2024 results to Salmar’s Q3 2024 results.

Quick comparison - Salmar vs Salmon Evolution

On one level, this is perhaps not a fair comparison – Salmar is a mature business with enormous scale and Salmon Evolution is a very young start-up, but it does illustrate, once depreciation is factored into the equation, how far out of step current performance at the company is with cost structures in the wider industry. When the cost of production is back-calculated, Salmon Evolution is 50% more expensive in Q4 and 64% more expensive in the year. I will note however, that Salmon Evolution seems to have out-performed on selling price - likely by a full 10 - 15 NOK/kg.

Cost of production elements

Again, perhaps not fair to compare a mature salmon company to a very young one but, my concern is that, given the excellent biological performance of their early generations, I’m not sure I understand where the potential for efficiency will come from when their fixed costs are so high. Here are the cost of production components identified in their financial statements.

Salmon Evolution - Cost Components - NOK

Change in inventory – this is a valuation item driven by IFRS rules, not really a cash item, so I’m going to ignore this value. You can see from the chart above that there is a big negative number in Q4 and a big positive number year-to-date.

Cost of materials – this would primarily be the feed fed to harvested fish. The feed fed to fish that has yet to be harvested would be reflected as a balance sheet item and would only hit the P&L once those fish were harvested. Same goes for feed in inventory – those purchases would be shown as an inventory item. Given the excellent biological results mentioned at the outset of this article, I would assume their feed conversion ratios are good and be surprised if there was much opportunity to improve on these costs. If reading through the report again, I can only find one mention of feed conversion so, perhaps they are wasting feed and there is opportunity for improvement. (Based on modern salmon diets, it is hard to imagine this being the case)

Personnel expenses – normally in a growth phase, wages of personnel involved in construction projects or other growth-related investments are allocated to capital costs and would not hit the income statement until the asset was depreciated. So, if my theory is correct, this number should reflect the cost of labour to produce the harvested fish. Perhaps there is an opportunity to become more efficient over time but if you look back to the Mowi Industry Handbook snip above, at 13.91 NOK/kg, the labour costs for Salmon Evolution are already lean. Even if we assume all labour is eliminated, it is not enough to bring costs into line with the rest of the industry.

Other operating expenses – this is a very big number, roughly 30 NOK/kg. If they become twice as efficient as they are today and then cut 50% of the labour above, they will get close to parity with the industry but, are these realistic assumptions? I don’t think so.

Depreciation – this number worries me. At 15.5 NOK/kg currently, it might go as low as 10 NOK/kg if their construction costs can be controlled and they are able to use a very long depreciation schedule, but it can’t be ignored when thinking about the long-term viability of the business. With a lot more investment to come, I think this will be a bigger and bigger problem for Salmon Evolution in the long-run.

Summary

I don’t want to be the miserable old man who does nothing but complain but, let’s face it, my feet are sore, I’m tired, and it’s my blog so I can write what I want. If you are still reading, you are a trooper.

Construction costs and depreciation estimates for a few land-based projects.

As a final comment, I have nothing but respect for the folks behind this project, they have a vision and have done an excellent job of putting things in motion. My concern, and challenge to them, however, is to demonstrate their path to profitability. From the numbers I am seeing in their reports, I don’t see it and have a concern that this production model won’t hold up in anything other than an extremely high-priced salmon market. Some very efficient salmon farmers were pushed into the red in Q3 2024 and it wouldn’t take much of a change in the market for the same to happen with this business.

I’ll mention again that I am not an accountant, so I welcome corrections and feedback. Such can be tendered in the comments section below, via email at Info@AlanWCook.com or LinkedIn.